Wharton’s Marshall W. Meyer and Penn Law’s Jacques deLisle discuss the escalating trade war between the U.S. and China.

The sudden escalation of the trade war between the U.S. and China in recent days could lead to longer-term shifts in not just China’s import programs but also in global manufacturing arrangements, according to experts at Wharton and the University of Pennsylvania. U.S. trade policies that are not rooted in economic considerations but are driven by political postures could prove costly for U.S. businesses and consumers, in addition to eroding the country’s leverage in global trade, they warned.

The latest conflict between the two countries has seen tit-for-tat actions. China on Monday announced that it will raise tariffs to between 5% and 25% on certain U.S. products entering its country, worth some $60 billion in annual trade. That came after the U.S. move on Friday to increase tariffs to 25% on $200 billion worth of Chinese goods, with a threat to extend that to another $300 billion worth of imports from China. In 2018, U.S. exports to China were $179.3 billion; imports were $557.9 billion. The U.S. goods and services trade deficit with China was $378.6 billion in 2018, according to government data.

“Tit-for-tat is an understatement,” said Wharton emeritus professor of management Marshall W. Meyer of the retaliatory tariffs China has imposed. China could end up hurting itself with those higher tariffs, especially in its imports of agricultural products from the U.S. “China has its own food crisis right now; they’re losing about half their pigs to African swine flu,” he pointed out. “So, not only do they need soybeans from the U.S., they’re going to need pork from the U.S. And it looks like they’re about to impose tariffs on a variety of U.S. farm products.”

“The real pain will come if China resorts to other methods which are within the Chinese repertoire,” said Jacques deLisle, professor of law and political science at the University of Pennsylvania, who is also director of the Center for East Asian Studies and deputy director of the Center for the Study of Contemporary China. “There’s quite a rich menu” of actions China could take, he added. “Tariffs are certainly part of the mix … but there are a lot of other mechanisms for making it painful for U.S. companies and for U.S. exporters.”

Meyer and deLisle discussed the Sino-U.S. tariff wars on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)

Beyond Tariffs

Among the actions at China’s disposal that could hurt the U.S. include “slow or extra-probing inspections” at customs when U.S. goods arrive, deLisle said. They could extend to “more zealous enforcement of any number of Chinese regulatory laws against American companies that are on the ground in China doing business, such as safety and licensing inspections,” he added.

“We’ve seen this happen before, and it’s very hard to police because it is essentially somewhat selective enforcement of legitimate laws on the books,” deLisle noted. In the past, China has slowed imports at customs and launched investigations into foreign companies during times of tension, according to a New York Times report.

“The real pain will come if China resorts to other methods which are within the Chinese repertoire.” –Jacques deLisle

There also have been instances where American firms have been “quite frustrated” about what they see as not fully fair scrutiny of investments such as with mergers and acquisitions of Chinese firms by American acquirers, deLisle continued. “The Chinese claim that as sort of tit-for-tat for the way we use the Committee on Foreign Investment in the U.S. (CFIUS) to police Chinese investment,” he said. “It’s getting fairly politicized, and one could easily see that ratcheting up. China now has laws that resemble U.S. laws that are somewhat more flexibly applied to undertake national security and national economic security scrutiny of acquisitions and investments.”

Meyer noted that the U.S. employs other tools beyond CFIUS to restrain China. “Maybe the most powerful tool would be export controls,” he said. “What if Qualcomm chips, for example, did not go to China? That would have a significant impact on their industry.”

A similar situation arose last year when the Trump administration banned U.S. companies from doing business with Chinese telecommunication equipment maker ZTE after the latter was found guilty of exporting controlled technology to North Korea and Iran. It eventually lifted that ban after Xi Jinping personally intervened in the matter and raised it with Trump.

“ZTE almost faced the death penalty when the Trump administration was going to impose [tariffs on] chip exports — that would have killed the company,” deLisle noted. The move could also have disrupted global supply chains in the telecom industry, according to a Knowledge at Wharton report at the time.

Permanent Impacts

If the trade war escalates, the U.S. risks “a permanent shift” in China’s supply base for soybeans, Meyer warned. “Brazil can produce almost as many soybeans as the U.S. [can],” he said. “We risk a long-term weakening of our agricultural sector, and that can’t be a good thing economically or strategically.”

“Going further with the tariff war is damaging for both countries,” said Wharton management professor Minyuan Zhao. “As we learned from game theory, the outcome in equilibrium is not always the optimal one.”

Similar threats lie in store for the U.S. in manufacturing as well, deLisle said. “If people start to think this [trade war with China] is a lasting phenomenon, you could see significant dislocations,” he added. “You could see companies relocating their supply chains; in some cases, that’s going to be moving production into China to avoid tariffs on goods exported from the U.S., and in some cases [it could mean] moving sources out of China to countries that don’t face the tariffs that China does – all that could be very disruptive.”

Higher tariffs on Chinese goods would make them costlier for U.S. consumers, but they may weather that in the short-term, DeLisle said. His bigger worry was about the longer-term effects of disrupted supply chains. “There is a pretty efficient global supply chain out there right now. If you start messing with it for reasons that are not rooted in economic fundamentals, but are rooted in policy choices about bilateral trade wars, then that’s costly,” he added.

The U.S. tariffs on imports from China could bring “a potentially seismic jolt to the global economy that is expected to raise prices for everyday products such as cell phones, sunglasses, cameras and televisions,” said a Washington Post report. “There will be price hikes at Target, Costco, Home Depot and Walmart,” the report added, quoting Nelson Dong, a Seattle-based partner with the law firm of Dorsey & Whitney.

“I’m worried that the Trump administration is being pushed on this by the far right – by the Steve Bannons of the world.” –Marshall Meyer

Zhao noted that Trump last week tweeted a claim that the U.S. loses $500 billion in trade with China. “The $500 billion that the U.S. pays every year to China is not just for Chinese goods and services,” she said. “It is also for Korean memory chips, Japanese touch screens, and Malaysian electronic components that are assembled into a ‘made-in-China’ product. It is for the German machinery, Australian iron ore, and Saudi oil that made the production possible. In fact, China runs a trade deficit with all these countries.”

In such a setting, any disruption to trade with China will be a disruption to the global supply chain, Zhao warned. “Of course, some countries will benefit, replacing China as the new assembler, while others will lose, facing reduced demand for their touch screens and iron ore. After all, if the eventual cost for imports increase, demand will go lower, and so will the need for all the intermediary inputs.”

On the Tariff Trail

According to deLisle, an escalating trade war with China seemed imminent after the Trump administration followed up its latest tariff increase on some Chinese products with a threat to extend that to all imports from China.

A New York Times report tracked the tariff actions and retaliations by the U.S. and China over the past year. On July 6 and August 23, 2018, the U.S. imposed 25% tariffs on $50 billion worth of Chinese technology goods including machinery, semiconductors, autos, aircraft parts and intermediate electronics components. That was part of a Section 301 probe by the U.S. into China’s intellectual property practices. China immediately retaliated with 25% tariffs on $50 billion worth of U.S. goods including soybeans, beef, pork, seafood, vegetables, whiskey and ethanol.

Next, on September 24, 2018, the U.S. imposed a 10% import tariff on $200 billion worth of Chinese goods including computer modems and routers, printed circuit boards, chemicals, building materials and furniture.

On May 10, 2019, the U.S. increased import tariffs on those products to 25%. On May 10, Trump also directed the U.S. Trade Representative to begin the process to impose 25% tariffs on remaining Chinese imports worth about $300 billion. They include consumer products such as cell phones, computers, clothing and toys. Three days later, China announced tariffs of between 5% and 25% on imports from the U.S. worth about $60 billion. About half the 5,140 U.S. products it listed would attract 25% tariffs, and they include liquefied natural gas, soy oil, peanut oil, petrochemicals, frozen minerals and cosmetics.

“Both parties believe that their demands are the legitimate ones, and both could be right at the same time.” –Minyuan Zhao

After all those moves, China would only have about $10 billion in U.S. imports left to levy in retaliation for any future U.S. tariffs, the report noted. However, it warned that retaliation could come in other forms, such as increased regulatory hurdles for U.S. companies doing business in China.

Testing Times for Both

The timing of the tariff war is unhelpful for China because it is already facing slowing economic growth, deLisle said. For the U.S., a big unknown is the impact of higher tariffs on Chinese goods after they take effect, he added.

The higher U.S. tariffs on imports from China apply to those that are shipped after the May 10 announcement; it would be a couple of weeks before the first shipments after that date arrive at U.S. ports, deLisle said. U.S. exporters have a little more time; China has said its new tariffs will go into effect after June 1.

The U.S. has also lost much leverage in its China dealings after it pulled out of the Trans-Pacific Partnership trade agreement two years ago, deLisle said. The TPP has since been replaced by the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), with Japan taking the lead role. “The U.S. is now being shut out of certain Asian markets – not completely, but it’s doing less well because it’s not inside that grouping, and that’s going to start to hurt some U.S. companies, especially U.S. exporters and service providers,” deLisle said. China is currently considering joining the 11-nation CPTPP.

Now that the U.S. is out of the TPP, Meyer noted that the U.S. is forced to act unilaterally against China, especially when it is not able to muster the support of its allies. “Some of our allies, particularly in Europe, are wavering as to who will set the agenda for trade and who’s going to set the platforms for technology going forward,” he said. “The U.S. is in a weakened position as a consequence.”

Searching for Solutions

According to deLisle, no easy solutions are in sight. “Both sides are now in a position where it’s going to be politically very tough to back down,” he said. “Xi Jinping needs not to appear to be caving [in] to the Americans. This image of him as the strong man and the wise leader is something he can’t afford easily to give up.”

Also, China has declared that it will stand firm in response to the increased U.S. tariffs on social media platforms and other media that are controlled by the Chinese government, deLisle said. That posturing was evident in China’s reaction when the U.S. accused it of reneging on promises to change Chinese laws, he noted. “The reaction in China – at least in the way it was sold to the Chinese public – was the U.S. can’t tell us how to make our domestic laws. That’s neocolonialism and extraterritorial reach.”

“As we begin to regionalize, and as we begin to set up fences globally, we’re also limiting commerce in a way that has nothing to do with tariffs.” –Marshall Meyer

“Both parties believe that their demands are the legitimate ones, and both could be right at the same time,” Zhao noted. “Because of the very different economic models and growth paths followed by the U.S. and China, we have not had a consensus on what is ‘right’ and what is ‘wrong,’ and what it really means to have a ‘level playing field.’”

Zhao recalled that Trump took office with the promise to “Make America Great Again,” and Xi took office with the promise of the “China Dream,” i.e., a return to the glorious days of the past. “So, even if they rationally see the advantage of a compromise, they may not want to put it in ink for fear of disappointing their support base,” she said.

The U.S. position on China is one of the few issues where there is bipartisan agreement, said Meyer. “[However], I’m worried that the Trump administration is being pushed on this by the far right – by the Steve Bannons of the world,” he added. Bannon, who was formerly Trump’s chief political strategist, has said that the “ultimate success is regime change [in China]. If we go down that path, we will have huge problems,” Meyer warned.

Chances of a reconciliation appear dimmer with the next U.S. presidential election approaching, said deLisle. According to him, both sides misread the likely outcomes of their respective positions. The Trump administration did not correctly gauge the effect of its tough stance on getting China to cave in to its demands.

“They underestimated the degree to which China would see [backing down] as a political setback – to be perceived as deferring too much to American demand,” deLisle said. On the other hand, China underestimated the degree to which its stance has eroded its support base in U.S. political circles. “There are people who are calling for a new Cold War, [while others] are much more skeptical about engaging [with] China,” he added.

“So far, the trade talks have provided little evidence that the two nations have found a formula for how to negotiate successfully” since Trump and Xi met last December, according to a Wall Street Journal report that traced the sequence of events in this case.

According to Meyer, the question both countries have to consider is: “Are we working cooperatively, or are we sliding toward protracted conflict that could go beyond the economic realm?” He advised that both sides “take a break, step back from the brink and explore arenas where maybe U.S. and China can cooperate.”